State Wins Round One

February 16, 1990

Angry federal retirees, pointing to more favorable rulings in other states, have vowed to appeal Tuesday's finding that Virginia does not have to refund $400 million in pension taxes it collected from them. But despite their ire and contrary to their charges that the decision was politically motivated, the ruling by Judge Donald Kent appears to have a sound legal basis.

The issue came to a head last year when the Supreme Court ruled that it is illegal for states to tax federal pension benefits while exempting the benefits of retirees paid under state and local pension plans. Although it might seem a simple point that if the taxes were illegal, they should be returned, the issue is decidedly more complex.

For one thing, the Supreme Court did not address the question of retroactive refunds. So the judge has taken the position that the ruling applies to the future but not the past.

For another, retirees in Virginia have sued under a state law allowing refunds for taxes collected either erroneously or improperly. But Judge Kent has ruled that the taxes were neither, since state officials had no way of foreseeing that a practice unchallenged since 1942 would be judged illegal by the court. Virginia, the judge said, had acted in good faith.

In addition, there is Supreme Court precedent for taking into consideration the financial impact a refund would have. That is exactly what the judge did: Unquestionably, returning $400 million would pose a considerable hardship on the state, requiring at least a tax increase and probably severe budget cuts. The judge took those points into account.

Ultimately, the state may lose and be ordered to repay the money. But Judge Kent's ruling seems well thought out. And it may be that Virginia's situation differs from those in states where retirees have received outcomes more to their liking. Stay tuned for round two to find out.